How To Invest In Commercial Real Estate: A Beginner's Guide

In the vast and diverse real estate investing landscape, opportunities come in various shapes and sizes, offering attractive financial rewards. While many new investors are initially drawn to single-family properties, commercial real estate (CRE) investing is often overlooked. Some may believe it's beyond their capabilities or financial reach, but the truth is that commercial real estate is a viable and lucrative option for investors at any level.

Commercial real estate investing distinguishes itself from its residential counterpart, presenting unique challenges and opportunities. In this article, we will demystify the world of commercial real estate and provide you with five invaluable tips to embark on a successful journey into this dynamic sector.

Whether you're a newcomer or a seasoned investor, understanding how to invest in commercial real estate will open doors to significant financial growth and diversification. To get the ball rolling, we’ll go over everything aspiring commercial real estate investors need to know, including:

• Commercial Real Estate Investing Trends 2023
• Commercial Real Estate Investing Forecast 2024
• What Is Commercial Real Estate?
• Five Types Of Commercial Real Estate
• Do You Need A License To Start Commercial Real Estate Investing?
• How To Invest In Commercial Real Estate: 5 Tips
• Loans For Commercial Real Estate Investing
• How To Get A Commercial Real Estate Loan
• Benefits Of Commercial Real Estate Investing
• Final Thoughts On How To Invest In Commercial Real Estate

*Before we begin our guide, we invite you to view our video on How To Get Into Real Estate With No Money! Host and CEO of Real Estate Skills, Alex Martinez, provides the perfect guide for beginners to invest in commercial real estate using no capital of their own!

Commercial Real Estate Investing Trends 2023

In the ever-evolving world of commercial investment, the trends of 2023 have left investors navigating unexplored territory. If for nothing else, one of the most impactful factors shaping the commercial real estate landscape was the onset of a once-in-a-generation pandemic. In an effort to combat inflation in the wake of COVID-19, the Federal Reserve initiated a long series of interest rate hikes. These hikes have reverberated for years, ultimately shaping the commercial real estate market.

Initially, the continuous interest rate hikes weakened the commercial real estate credit market. Bearing the recent collapse of two regional banks in March 2023, lenders adopted a more cautious approach. As a result, credit became tighter, making it more challenging for investors to secure financing for their commercial real estate ventures.

Small and mid-sized banks, which hold a substantial portion of commercial real estate loans, reported stricter lending standards during the year's second quarter, further contributing to the tightened credit environment. Delinquency rates for commercial real estate loans increased (while still historically low).

The repercussions of these interest rate hikes have been felt across various commercial real estate sectors. Higher interest rates have led to increased challenges in handling low-interest loans as they mature at higher rates. Consequently, commercial real estate sectors have faced higher vacancy rates and slower rent growth, highlighting the prevailing trends of the current market.

According to the National Association of Realtors, the office space sector has been significantly impacted, with the office vacancy rate hitting an all-time high at 13.5% in August 2023 due to negative net absorption and new supply. On the other hand, while experiencing decelerated rent growth, the multifamily sector has seen growing demand as potential homeowners face obstacles posed by higher mortgage rates. Retail remains a resilient sector, boasting the lowest vacancy rate among all sectors.

These trends serve as essential considerations for investors looking to invest in commercial real estate, highlighting the importance of staying informed and adaptable in this ever-changing landscape.

Read Also: Selling Commercial Real Estate: 9 Steps For Sales Success

Commercial Real Estate Investing Forecast 2024

As of today, all commercial real estate investing forecasts are at the mercy of the Federal Reserve. If, for example, the Fed sticks to its word and opts for just one more rate hike and then maintains a stable stance, commercial real estate investors can anticipate a more predictable and potentially favorable environment in the coming year. Here's what might unfold:

• Stabilization In Credit Conditions: Credit conditions could stabilize with fewer interest rate fluctuations; this would mean securing financing for commercial real estate investments may become more accessible and predictable. Investors would likely face less stringent lending standards, making it easier to fund their projects.
• Rent Growth & Vacancy Rates: A steadier interest rate environment could lead to more consistent rent growth and slower increases in vacancy rates. Investors would welcome this scenario as it provides greater predictability for income streams and property performance.
• Increased Investment Activity: A more stable interest rate environment encourages increased commercial real estate sector investment activity. Investors previously hesitant due to uncertainty may be more inclined to enter the market, leading to heightened competition for commercial real estate properties.
• Asset Appreciation: The commercial real estate market could witness steady asset appreciation as investor confidence grows. Properties may appreciate over time, offering opportunities for capital gains.

On the other hand, if interest rates stop rising and gradually start to come down, the commercial real estate industry could experience further positive effects:

• Improved Financing Terms: Lower interest rates would translate into improved financing terms for commercial real estate investors, resulting in reduced borrowing costs and potentially higher returns on investment.
• Increased Demand: Lower rates may stimulate increased demand for commercial properties as investors seek to exploit favorable financing conditions; this could lead to a more robust market with a higher volume of transactions.
• Greater Price Appreciation: With more favorable financing, investment property prices may be appreciated faster with more favorable financing, offering substantial capital appreciation potential.

A scenario of one more rate hike followed by a stable rate environment or a gradual rate decline can bode well for commercial real estate investors. It would provide a more predictable and potentially prosperous landscape, encouraging investment activity and fostering improved financing conditions.

However, predicting the commercial real estate market is a fool’s errand. Nobody knows exactly how the commercial real estate market will play out, but it is possible to make more informed decisions based on the trends witnessed in 2023. As a result, commercial real estate investors need to stay educated and adaptable to seize opportunities in this evolving market.

What Is Commercial Real Estate?

Commercial real estate refers to properties primarily used for business and income-generating purposes rather than residential living. Its focus on commerce and profit generation sets it apart from residential and multifamily real estate.

Commercial real estate encompasses various property types, including mixed-use shopping centers, office buildings, retail centers, industrial warehouses, and hospitality establishments. There are several more types of commercial buildings, but they all have one thing in common: they are all income-producing properties designed for business purposes.

Unlike residential properties that house individuals and families, commercial properties are leased to businesses, generating rental income for their property owners. As a result, investing in commercial real estate offers unique opportunities, making it an attractive option for diversifying real estate portfolios and pursuing income-generating ventures.

Five Types Of Commercial Real Estate

When it comes to commercial real estate, investors encounter a diverse landscape of property types, each with unique characteristics and investment potential. Understanding the different categories is essential for making informed investment decisions.

Here, we'll explore the five most common types of commercial real estate, providing insights into their key attributes and investment opportunities. Whether you're a seasoned investor or just starting in the commercial real estate arena, this list will help you navigate the varied options available in the market:

1. Industrial
2. Multifamily
3. Office
4. Retail
5. Special Purpose

Industrial

Industrial real estate comprises properties designed for manufacturing, production, warehousing, distribution, and research and development. Its focus on functionality and efficient operations sets industrial real estate apart from other commercial properties. These assets often feature large, open floor plans, high ceilings, and heavy-duty infrastructure to accommodate industrial processes and equipment.

Investing in industrial real estate can provide stable income streams, primarily when leased to reliable tenants on long lease terms. With the rise of e-commerce and increased demand for logistics and distribution centers, industrial properties have gained attention from commercial property investors as a promising sector for growth and income potential.

Multifamily

Multifamily real estate refers to residential properties that accommodate multiple households within a single structure or complex. What distinguishes multifamily real estate from other commercial sectors is its focus on residential use, with the primary purpose being housing rather than business operations. These properties include apartment buildings, townhouses, and condominiums, offering investors a wide range of options.

Multifamily real estate can provide consistent rental income and the potential for long-term capital appreciation. It is an appealing choice for beginners in commercial real estate due to its relatively lower entry barriers compared to other asset classes, making it an excellent starting point for those looking to invest in commercial real estate.

Office

Office real estate involves properties specifically designed and utilized for office-related activities, such as corporate headquarters, coworking spaces, and professional services offices. What sets office real estate apart from other commercial sectors is its primary focus on accommodating businesses and organizations rather than residential or industrial purposes.

Investing in office real estate offers the potential for stable rental income, often through long-term leases, and the opportunity to work with diverse tenants. Getting into commercial real estate through office properties can expose investors to various industries, contributing to portfolio diversification and potential for value appreciation.

Retail

Retail real estate includes properties designed for businesses to sell goods and services directly to consumers. Unlike other commercial real estate types, such as office or industrial, retail properties are optimized for consumer foot traffic and feature storefronts and commercial spaces. What sets retail real estate apart is its connection to consumer behavior and spending patterns.

Investing in commercial property within the retail sector offers potential rental income driven by consumer demand and the opportunity to engage with diverse retailers. It's a unique sector where success often hinges on location, visibility, and the ability to attract a wide range of retailers and customers.

Special Purpose

Special purpose real estate refers to properties designed for a particular, often singular use, making them distinct from other types of commercial real estate. These properties serve niche purposes, such as churches, schools, hospitals, or theaters. What sets special purpose real estate apart is its limited adaptability.

While other commercial properties can be repurposed more easily, special-purpose properties are often challenging to convert to alternative uses due to their unique design and infrastructure. Investing in commercial real estate for beginners might be better suited to more flexible property types, as special-purpose real estate can present higher risks and specialized knowledge requirements.

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Do You Need A License To Start Commercial Real Estate Investing?

Investors do not need a real estate license to invest in commercial real estate because purchasing, owning, and managing commercial properties primarily involves financial and business transactions rather than real estate agent activities. However, having a real estate license can still benefit commercial real estate investors.

It provides a deeper understanding of real estate laws, regulations, and market dynamics. This knowledge can help investors negotiate better commercial real estate deals, identify opportunities, and effectively navigate complex transactions.

Read Also: How To Become A Commercial Real Estate Agent - 3 Tips

How To Invest In Commercial Real Estate: 5 Expert Tips

For aspiring commercial real estate investors, success lies in acquiring knowledge and developing a solid strategy. In this competitive market, understanding the intricacies of commercial real estate is second to none. This list of tips will guide you in your journey, covering everything from learning about the industry and analyzing comps to mastering formulas and avoiding common pitfalls, ensuring you are well-prepared to navigate the world of commercial real estate investing:

1. Learn About Commercial Real Estate Investing
2. Analyze Commercial Real Estate Comps
3. Learn Commercial Real Estate Formulas
4. Set Aside Funds For Cost Contingencies
5. Know The Mistakes To Avoid

Learn About Commercial Real Estate Investing

Learning about commercial real estate investing offers new investors a significant advantage by equipping them with the knowledge and expertise necessary to make informed decisions and navigate the complexities of this field. It provides insights into property types, market trends, and investment strategies, allowing investors to identify lucrative opportunities and mitigate risks effectively.

To increase their acumen in commercial real estate, new investors should consider the following strategies:

• Education: Enroll in commercial real estate courses, attend seminars, and read books or articles authored by experienced investors and professionals in the industry.
• Networking: Build relationships with seasoned commercial real estate investors, brokers, and professionals who can provide valuable insights and mentorship.
• Market Research: Continuously analyze market data, property performance metrics, and economic trends to stay informed about potential investment locations and opportunities.
• Hands-On Experience: Start with smaller investments or partnerships to gain practical experience and learn the intricacies of commercial real estate firsthand.
• Real Estate Associations: Join local or national real estate associations to connect with like-minded professionals and access valuable resources.

By actively pursuing these avenues, new investors can enhance their understanding and expertise in commercial real estate investing, increasing their chances of making successful and profitable investments.

Analyze Commercial Real Estate Comps

Analyzing real estate comps is advantageous for new investors in commercial real estate as it helps them make informed decisions by providing insights into market values, rental rates, and potential returns. By studying comparable properties, investors can accurately assess the fair market value of their target property and ensure they are not overpaying or missing out on a lucrative opportunity.

To effectively analyze real estate comps, new investors should consider these best practices:

• Identify Comparable Properties: Look for properties with similar characteristics, such as location, size, type, age, and use. Focus on properties within the same submarket for the most accurate comparisons.
• Review Purchase Prices & Rent Data: Examine recent sale prices and rental property rates of comparable properties. Pay attention to any trends or fluctuations in pricing over time.
• Evaluate Property Features: Compare specific features like amenities, condition, occupancy rates, and tenant quality to determine how they affect property values.
• Assess Location: Consider the proximity to essential amenities, transportation hubs, and demographic factors impacting property values.
• Consider Market Conditions: Analyze current market conditions, including supply and demand dynamics, economic trends, and industry forecasts, to gauge the investment's potential for appreciation or income generation.
• Engage With Professionals: Seek guidance from real estate appraisers, real estate brokers, or experienced investors who can provide valuable insights and help interpret comp data accurately.

By diligently analyzing real estate comps using these strategies, new investors can make well-informed decisions, negotiate favorable deals, and maximize their returns in the competitive landscape of commercial property investment.

Learn Commercial Real Estate Formulas

Learning commercial real estate formulas and equations is advantageous for new investors as it equips them with the tools to evaluate the financial aspects of potential investments accurately. These formulas allow investors to assess the property's performance, estimate returns, and make informed decisions.

Here are some essential formulas and how to calculate them:

Cap Rate (Capitalization Rate):

• Advantage: Helps determine the property's potential return on investment.
• Formula: Cap Rate = Net Operating Income (NOI) / Property Value
• Calculation: Divide the property's NOI by its current market value or acquisition cost to find the cap rate. A higher cap rate typically indicates a higher potential return.

Read Also: What Is A Good Cap Rate? Calculator & Formula for Real Estate

Cash-On-Cash Return:

• Advantage: Measures the return on the actual cash invested in the property.
• Formula: Cash-on-Cash Return = Annual Cash Flow / Initial Cash Investment
• Calculation: Divide the property's annual cash flow (income minus expenses) by the initial cash investment (down payment and closing costs).

Debt Service Coverage Ratio (DSCR):

• Advantage: Assesses the property's ability to cover its debt obligations.
• Formula: DSCR = Net Operating Income (NOI) / Debt Service (Loan Payments)
• Calculation: Divide the NOI by the annual debt service (principal and interest payments). A DSCR above 1 indicates positive cash flow to cover debt.

Gross Rent Multiplier (GRM):

• Advantage: Helps quickly estimate a property's value based on rental income.
• Formula: GRM = Property Value / Gross Rental Income
• Calculation: Divide the property value by the gross rental income (total rental income before expenses).

Price per Square Foot:

• Advantage: Useful for comparing property values based on size.
• Formula: Price per Square Foot = Property Price / Total Square Feet
• Calculation: Divide the property price by the total square footage.

To use these formulas effectively, new investors should gather accurate financial data for the property, including income, expenses, and financing details. Consulting with experienced professionals or using specialized real estate investment software can also streamline the calculation process and improve accuracy.

Set Aside Funds For Cost Contingencies

Setting aside funds for cost contingencies in commercial real estate investing is advantageous. It offers investors financial protection against unforeseen expenses and ensures a more realistic assessment of potential returns. Here's why it's beneficial:

• Risk Mitigation: Cost contingencies act as a safety net, reducing the financial impact of unexpected events or repairs.
• Accurate Financial Planning: By accounting for contingencies, investors create a more accurate budget and financial forecast for their investments.
• Peace Of Mind: Having contingency funds in place provides peace of mind, allowing investors to focus on their investment strategy without constant worry about unexpected costs.

Key contingencies to budget for include:

• Maintenance & Repairs: Budget for ongoing maintenance and potential repairs to keep the property in good condition.
• Vacancy Costs: Account for periods when the property may be vacant and not generating rental income.
• Tenant Improvements: If leasing to commercial tenants, allocate funds for tenant improvement allowances or build-outs.
• Legal Fees: Include provisions for legal fees related to lease negotiations, disputes, or property-related issues.
• Environmental Assessments: In some cases, ecological assessments may be required, so budget for these evaluations.
• Market Fluctuations: Consider potential market fluctuations affecting property value or rental rates.
• Capital Expenditures: Set aside funds for major capital expenditures, such as replacing a roof or HVAC system.
• Unexpected Costs: Be prepared for unforeseen costs, emergencies, or regulatory changes that may impact the property.

By incorporating cost contingencies into their investment plan, new commercial real estate investors can better navigate the challenges and uncertainties of property ownership. This approach enhances long-term success and minimizes financial risks.

Know The Mistakes To Avoid

Knowing what mistakes to avoid in commercial real estate investing is advantageous because it helps new investors navigate the complex terrain more effectively, reducing potential setbacks and financial losses. Here are some common mistakes to avoid:

• Inadequate Due Diligence: Skipping thorough research on the property, market, and tenants can lead to unforeseen issues.
• Overestimating Rental Income: Overly optimistic rent projections can result in financial shortfalls.
• Ignoring Property Inspections: Neglecting property inspections may lead to expensive repair costs.
• Underestimating Expenses: Failing to budget for operating expenses accurately can strain cash flow.
• Neglecting Market Analysis: Overlooking market trends and dynamics may lead to poor investment decisions.
• Overleveraging: Taking on excessive debt can increase financial risk, especially in a downturn.
• Ignoring Legal Matters: Neglecting legal aspects like lease agreements and zoning laws can lead to disputes or fines.
• Poor Property Management: An inadequate property management company can result in tenant dissatisfaction and vacancies.
• Lack Of Diversification: Concentrating investments in a single property or market increases risk exposure.
• Neglecting Exit Strategies: Failing to plan for various exit scenarios can limit flexibility.

Loans For Commercial Real Estate Investing

Investors utilize various types of loans to finance their commercial real estate investments, each tailored to specific needs and circumstances. Here are some of the most common types:

• Traditional Commercial Mortgages: Similar to residential real estate mortgages, these loans offer competitive interest rates and terms, typically used for properties such as offices, retail spaces, or family homes with multiple units. They require substantial down payments, strong credit, and a thorough financial review.
• SBA 504 Loans: Backed by the Small Business Administration (SBA), these loans assist small business owners in purchasing commercial properties. They often require a lower down payment and offer favorable terms. However, they come with specific eligibility criteria and property use restrictions.
• Bridge Loans: Short-term financing options that help investors acquire, renovate, or reposition properties before securing long-term financing; bridge loans offer quick access to capital but often have higher interest rates and fees.
• Construction Loans: Ideal for investors looking to develop or conduct renovations on commercial properties. These loans cover construction costs and are usually converted into long-term mortgages once the project is completed. Interest rates may vary during the construction phase.
• Hard Money Loans: Typically offered by private lenders or investors, hard money loans provide quick access to capital but come with higher interest rates and shorter terms. They are often used for time-sensitive investments or when traditional financing is unavailable.
• CMBS Loans (Commercial Mortgage-Backed Securities): These are loans bundled together and sold as securities to investors. They offer competitive rates and terms but involve a complex approval process and may be more suitable for larger investments.
• Portfolio Loans: Offered by local banks, credit unions, or private lenders, portfolio loans are more flexible and tailored to individual investors' needs. They may accept unconventional properties or provide customized terms with a good track record.
• Agency Loans: Backed by government agencies like Freddie Mac or Fannie Mae, these loans are suitable for multifamily properties. They often offer competitive rates and longer terms, making them appealing to investors in this sector.
• Seller Financing: In some cases, seller financing is an option for buyers, allowing investors to acquire properties without traditional lenders. Terms and conditions can vary based on negotiations with the seller.

Read Also: How To Start Investing In Real Estate With No Money (2023) 

How To Get A Commercial Real Estate Loan

Securing a commercial real estate loan involves several essential steps, each of which demands careful consideration and preparation:

• Preparation & Research: Before diving into the loan application process, investors should thoroughly research and understand their investment goals, the type of property they wish to acquire, and the financing required.
• Choose The Right Lender: Identify lenders or financial institutions specializing in commercial real estate financing. Compare their terms, rates, and lending criteria to find the best fit for your needs.
• Loan Application: Submit a comprehensive loan application to the chosen lender. This application should include essential financial documents, such as tax returns, bank statements, and property-related information.
• Initial Screening: The lender will review your application to assess your creditworthiness, financial stability, and the viability of the investment. This initial screening helps determine whether your application proceeds to the next stage.
• Letter of Intent (LOI): If your application shows promise, the lender may issue an LOI, outlining the proposed terms and conditions of the loan; this serves as a preliminary agreement and basis for further negotiations.
• Property Appraisal & Due Diligence: The lender will thoroughly appraise the property to determine its current market value and condition. Simultaneously, due diligence may include property inspections, environmental assessments, and title searches.
• Underwriting: Once due diligence is complete, the lender's underwriting team evaluates all information to determine the risk and feasibility of the loan. They will assess your creditworthiness, the property's income potential, and other relevant factors.
• Loan Approval & Commitment Letter: If the lender approves the loan, they will issue a commitment letter outlining the final loan terms and conditions. Review this letter carefully to ensure it aligns with your expectations.
• Loan Closing: At this stage, both parties sign the loan documents, and the funds are disbursed to complete the purchase or refinance of the commercial property. Investors may need to bring a down payment to the closing table.
• Loan Servicing: After closing, investors must make regular payments on the loan as per the agreed terms. The originating lender may manage loan servicing or a third-party servicer.
• Asset Management: Successful investors continue actively managing their commercial properties to maximize returns, maintain property value, and meet loan obligations; this includes property maintenance, tenant management, and financial oversight.
• Refinancing Or Payoff: Depending on the investment strategy, investors may refinance their commercial real estate loans to access additional capital or reduce interest rates. Alternatively, they can aim to pay off the loan entirely, resulting in full property ownership.

Read Also: Real Estate Financing: The 6 Best Funding Options For Investors

Benefits Of Commercial Real Estate Investing

Commercial real estate investing offers numerous benefits for investors looking to diversify their portfolios and achieve financial success. Here are some key advantages:

• Steady Income Streams: Commercial properties, such as office buildings, retail centers, and apartment complexes, often generate reliable and consistent rental income. This steady cash flow can provide financial stability and cover property expenses, including mortgage payments.
• Appreciation Potential: Commercial properties have the potential for long-term appreciation, creating liquidity for owners. As the property's value increases, investors can build equity and realize substantial capital gains when selling or refinancing.
• Portfolio Diversification: Commercial real estate can be a valuable diversification tool within an investment portfolio, allowing investors to own buildings serving multiple industries.
• Tax Benefits: Commercial real estate investors can leverage various tax advantages, such as depreciation deductions, interest expense deductions, and 1031 exchanges, to reduce their taxable income and increase overall returns.
• Professional Tenant: Commercial properties often attract professional and long-term tenants, such as businesses and government entities. These tenants tend to sign longer leases, reducing vacancy risk and turnover costs.
• Triple Net Leases (NNN): In some commercial real estate transactions, tenants are responsible for property-related expenses, including property taxes, insurance, and maintenance costs. This lease arrangement can minimize the landlord's responsibilities and increase net income.
• Potential For Passive Income: For investors who prefer a more hands-off approach, hiring property managers can make commercial real estate a relatively passive investment. Property managers handle day-to-day operations, allowing investors to focus on other ventures.
• Hedge Against Inflation: Commercial real estate investments often benefit from inflation because they typically involve long-term leases with rent escalations. As the cost of living rises, property income can increase accordingly.
• Multiple Exit Strategies: Investors have various exit strategies in commercial real estate, including selling, refinancing, or converting properties to different uses. This flexibility offers options in other market conditions.

Understanding how to invest in commercial real estate can unlock these benefits and create opportunities for wealth-building and financial success. However, investors must conduct thorough due diligence, seek professional advice, and evaluate potential properties to make informed investment decisions.

Final Thoughts On How To Invest In Commercial Real Estate

Commercial real estate offers many opportunities for investors seeking financial freedom and portfolio diversification. That said, learning how to invest in commercial real estate correctly is paramount to reap the greatest rewards. From steady income streams and potential for appreciation to tax advantages and portfolio diversification, commercial real estate can be a lucrative addition to your investment portfolio.

However, success in commercial real estate requires diligent research, a deep understanding of the market, and a commitment to learning from both successes and challenges. By following the tips and insights shared in this article, aspiring commercial real estate investors can navigate the complexities of this field, minimize risks, and increase their odds of achieving their investment goals.

Ready to elevate your real estate investing portfolio to new heights? Contact Real Estate Skills today and unlock the knowledge, strategies, and support you need to succeed in commercial real estate investing. Whether you're a seasoned investor looking to expand your horizons or a newcomer eager to make your mark, our comprehensive resources and expert guidance will help you confidently navigate the commercial real estate landscape.